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By XE Market Analysis January 22, 2021 4:42 am
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    XE Market Analysis: Europe - Jan 22, 2021

    The dollar has firmed up on a safe haven bid with the reflation trade having come to a firm stop. The DXY dollar index lifted moderately to a 90.26 high after basing out at a nine-day low at 90.05. The U.S. currency gained only marginally against the euro and yen, but racked up gains of around 0.4% to 0.5% against the pound and dollar bloc currencies. EUR-USD ebbed back from an eight-day high at 1.2178, while USD-JPY lifted to a two-day high at 103.70. Global equity indices corrected from record highs in the cases of the main U.S. indices and the MSCI Asia-Pacific index. Base metals are also markedly lower. Lofty valuations and an increasing level of concern about the Covid situation have warranted increasing investor caution. Covid restrictions have been implemented across northern China, and the new highly transmittable variant of the SARS-Cov2 coronavirus -- aka the British variant, where it was first detected -- has shown up as far afield as Beijing and Australia. The EU looks set ban travel to the UK, while the UK has already imposed much tough international travel restrictions. (Scientists in the lockdown sceptic camp, which have been largely censured by most of the dominant media outlets, have been warning that suppressing the virus with lockdowns would set the evolutionary conditions for more contagious variants). The rollout of the Covid vaccinations globally has also been proving to be bumpy. Elsewhere, cryptocurrencies dropped sharply again, which will only add to the reputation for being too volatile for serious institutional investors to touch. Reports that the Biden administration has tighter regulations for cryptocurrencies on its 'to do' list have been driving the cryptos lower. Bitcoin was showing a 11% loss on the day, as of the early London morning, at $30,860 -- which is nearly 26% below the record high seen earlier in the month. The virtual coin earlier traded below $29,000 for the first time since January 1.

    [EUR, USD]
    EUR-USD has become re-established in the 1.2100s, above one-month low that was seen on Monday at 1.2055. The ECB yesterday did the expected and left overall policy settings unchanged. If anything the statement was a tad more hawkish than most had been anticipating, which gave the euro a prop, in that it spelled out that the PEPP volumes doesn't need to be used in full, with President Lagarde also highlighted that while virus restrictions have tightened since the last meeting, there were also major positive developments that should support the medium term recovery, including the Brexit deal. Clearly the ECB is eager to keep spreads in and prevent markets from running away with the recovery story too early, but in the central scenario, the central bank will likely maintain the wait and see stance for the foreseeable future. As for the dollar, the currency has firmed up today amid a correction in global stock markets. The 'looking-past-Covid' reflation trade remains a valid big-picture investment thesis, though the prevailing reality of increasing Covid restrictions, the new highly transmittable British variant, along with a less-than-smooth rollout of vaccinations, is warranting increasing investor caution, especially given lofty valuations. Overall, we remain bullish on EUR-USD. The latest update of the 'Big Mac index' of the Economist magazine, which is a PPP measure of relative currency valuations, found the euro to be 9% undervalued relative to the dollar.

    [USD, JPY]
    USD-JPY lifted to a two-day high at 103.70, though the yen fared better against the underperforming dollar bloc, which like other cyclical currencies, have been impacted by a correction in global equity and commodity markets. The BoJ this week left the main monetary policy settings unchanged, as had been widely expected. The deadlines for some funding programs were extended, with the central bank taking a grimmer view on the current state of the economy, although it also upped its growth forecast for the expected recovery in the next fiscal year. The yen's performance should continue to derive from the level of risk appetite in global markets. Japan's surplus economy, where yield-seeking domestic investors are apt to invest in foreign assets during times of confidence, but repatriate funds when times are uncertain, has established the yen as a low-beta haven currency.

    [GBP, USD]
    The pound has dropped back, once again proving sensitive to risk-off conditions in global markets, which has been a reoccurring theme over the pandemic era. This has see the UK currency correct from respective eight- and 32-month highs that were seen against the euro and dollar yesterday. Ironically, global equity markets have corrected on reports that the so-called British variant of SARS-Cov2, which is highly transmittable, has been detected as far afield as Beijing and Australia, which has been the cause of increasing levels of societal restrictions. Bigger picture, we remain bullish on the pound. The Economist magazine's Big Mac index, a measure of 56 currency valuations according to the theory of purchasing power parity, which showed the the pound to be 22% undervalued against the dollar. Associated with this view is the fact that the UK is among the leaders of the pack in the rollout out of Covid vaccinations, and is on track to have nearly 25% of the population vaccinated including nearly all of the at-risk groups as soon as mid February. At this point, the UK government will start reversing out of restrictions, although most likely this will be in a cautious stage-by-stage process over several months. The preliminary UK PMI surveys for December are up tomorrow, though aren't likely to have much impact, as they will reflect the grim realities of the 'the now' (Covid lockdowns) more than the 'post Covid' world that many investors are betting on. The median forecast for the composite PMI is 45.5 versus the 50.4 level seen in December.

    [USD, CHF]
    Policymakers at the SNB retain a chronic disquietude about the franc's value. Unlike most central banks, the SNB explicitly incorporates the franc into monetary policy to ward off speculative purchases of the currency, which would impart deflationary forces (via cheaper imports) with the consequential impact of an unwelcome tightening in real interest rates. The central bank repeated at its latest quarterly monetary policy review that the franc remains "highly valued" and said it is ready to intervene directly in the foreign exchange market.

    [USD, CAD]
    USD-CAD has lifted to two-day highs near 1.2700, extending a rebound from yesterday's 33-month low at 1.2589. Oil prices came off the boil after nearing 11-month highs earlier in the week, with data showing an unexpected build in U.S. weekly crude inventories curtailing the market's upside. The global reflation trade has also come of the boil. Front-month WTI crude futures have dropped back to the lower $52.00s after posting a one-week high at $53.82 earlier in the week. We had been noting reasons for caution with regard to oil's upside potential, given demand-sapping Covid restrictions across the northern hemisphere, and with tanker-tracking data showing compliance among OPEC+ producers to maintain output quotas falling to 75% in December.

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